TEST PLUG (TAPÓN DE PRUEBA)

The global market for corporate control has evolved immensely over the past decade in terms of both size and diversity. One hotly debated aspect of this trend is the huge diversity of the very countries where mergers and acquisitions (M&As) take place. Countries differ considerably in their governance structures, accounting standards and disclosure practices, and protect investors to varying degrees. This has obvious economic implications in cross- border M&As in particular, where governance and legal spillovers have been shown to affect shareholder returns (Goergen and Renneboog, 2004; Kuipers, Miller and Patel, 2003), the takeover premium demanded by target shareholders (Starks and Wei, 2004), the choice of target firms (Rossi and Volpin, 2004), and even the valuation of entire industries (Bris and Cabolis, 2002).

If stock performance exhibits great cross-country variation around M&A announcements, so should the performance of corporate bonds. From the perspective of bondholders, two notable features set countries apart: the extent of creditor influence on corporate decision making and the quality of legal protection afforded creditors. Creditor influence is primarily a function of the corporate governance regime in place. In the Anglo-American market-oriented regimes, creditors are seen as independent parties contracting with the firm and maintaining a

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largely arm‟s-length relationship with it (Jensen and Meckling, 1976). In the stakeholder- oriented regimes of Continental Europe, the creditor-firm relationship is very different. Banks act as concentrated lenders and delegated monitors, and actively participate in corporate governance along with other risk-averse stakeholders (Diamond, 1991). This dictates that M&As should be more bondholder-friendly in stakeholder-oriented systems than in the Anglo-American world, and that the cross-border deals which combine the two regimes should induce considerable governance spillovers.

Another important aspect of cross-border M&As is that they combine firms from jurisdictions which protect creditors to varying degrees. La Porta et al. (2000) argue that there are limitations to the functional spillover of creditor rights, because corporate assets remain under the jurisdiction of the country where they are physically located. However, exposure to a more creditor-friendly jurisdiction should still prompt management to avoid excessive risk- taking, by exacerbating the threat and implications of insolvency proceedings against the firm if it goes into financial distress. Creditors may further intensify this threat through jurisdiction shopping, whereby they race against management and each other to seek out a jurisdiction that best supports their legal position and ensures maximum satisfaction for their claims. Legal arbitrage by powerful secured creditors is not at all hypothetical, and is strongly encouraged by the recent wave of bankruptcy law reforms which enhance jurisdictional co- operation in cross-border insolvencies and largely defeat the territoriality principle referred to by La Porta et al. (2000). The ensuing reduction in the agency costs of debt should benefit all creditor classes in the firm, whether or not they have the ability or incentive to access other jurisdictions themselves.

Existing studies on bondholder wealth preclude the impact of such institutional factors by confining their focus to US domestic deals. Rather, they test three main hypotheses on the risk effects of M&As. Firstly, bondholders benefit at the expense of shareholders from reduced risk through a co-insurance of cash flows, which is likely to be greater in diversifying deals (Galai and Masulis, 1976). Secondly, shareholders may seek to reverse bondholder gains by increasing leverage at the event or thereafter (Dennis and McConnell, 1986). And thirdly, bondholder wealth is affected by the relative pre-merger riskiness of bidder and target (Shastri, 1990). Overall, there is little evidence of bondholders benefiting from M&As at all. Billett, King and Mauer (2004) report losses for bidder bondholders, while target bondholders gain in junk-grade but lose in investment-grade firms. Earlier, Eger (1983) reports significant gains, but she only considers stock-for-stock deals to omit wealth reversals through the payment method. Maquieira, Megginson and Nail (1998) confirm the same gains for non-

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diversifying deals only, where more wealth is created but the scope for co-insurance is limited. Kim and McConnell (1977), Asquith and Kim (1982), Walker (1994) and Dennis and McConnell (1986) find that bondholders are insignificantly affected by M&As.

This chapter expands on these results by showing how cross-country differences in governance and legal standards affect bond performance in European bidding firms around M&A announcements. I use euro- and sterling-denominated Eurobonds to investigate bond price changes in both domestic and cross-border deals across Europe. These securities are highly standardized and very liquid, which permits the direct comparison of their returns across multiple countries (Gabbi and Sironi, 2005). However, they also limit the scope of my analysis to investment-grade bidding firms, since junk-grade Eurobonds are rarely issued, and the large, creditworthy issuers are rarely targeted by takeover bids. It is also worth pointing out that Eurobonds holders are prevented from entering insolvency arbitrage, because Eurobond contracts always specify a governing law. Nonetheless, they should be highly sensitive to changes in the position and bargaining power of diligent secured creditors vis-à- vis the firm, because they hold unsecured claims ill-protected by covenants and have little credibility themselves in threatening with insolvency litigation.

The empirical results presented in this chapter show that cross-country differences in governance and legal standards are indeed as strong predictors of bond performance in M&As as either deal or firm characteristics. Firstly, bidder bonds perform systematically better

ceteris paribus in deals involving Continental European firms, and actually earn significantly positive abnormal returns. This finding is consistent with the strong representation of creditor interests in stakeholder-oriented governance regimes compared with the market-oriented systems of the Anglo-American world. Creditor participation in corporate governance may also explain why the bondholders of Continental European bidders are less sensitive than their UK peers to a deal‟s asset and financial risk implications, but respond strongly to any governance-related risks and uncertainties which may dilute the position of creditors vis-à-vis

the firm..

Secondly, there is substantial variation in bond performance depending on whether the deal is domestic or cross-border. All else equal, bidder bonds underperform in cross-border M&As relative to domestic deals. This may reflect concerns over informational asymmetries, as well as the added legal uncertainties and inefficiencies associated with the default of internationally diversified firms. However, cross-border deals also induce highly significant governance and creditor protection spillovers, such that bonds perform better when their firm becomes exposed to a stakeholder-oriented governance regime or a jurisdiction with better

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creditor rights and debt enforcement. It is remarkable that Eurobond holders respond so strongly to such considerations, because not only are they prevented from insolvency arbitrage, but their firms tend to be large and internationally diversified already. What this demonstrates is that creditor protection spillovers do lead to a general reduction in the agency costs of debt, thereby benefiting all creditor classes regardless of their seniority.

My results also provide other interesting additions to the literature. I find that bidder bondholders benefit less from takeover bids made for public targets. Bonds perform better when the target is relatively small, and bondholders are generally perceptive of changes in both asset risk and financial risk. Finally, bidder bonds fare better when the target shareholders are approached directly with a tender offer, circumventing management.

The remainder of this chapter is outlined as follows. Section 3.1 reviews the theoretical literature and makes prior conjectures on the drivers of bondholder wealth changes. Section 3.2 contains descriptive statistics on the sample and describes the methodology. Section 3.3 provides an extensive discussion of the empirical results, while Section 3.4 describes robustness checks and possible extensions. Finally, Section 3.5 allows for some concluding remarks.